Blog Post

Day traders, angels and venture capital: The internet changes everything, including money

London is the grandfather of economic excess and perhaps an appropriate role model for New York and San Francisco, the new Babylons of the post-millennial world. It is hard to escape the presence of money — fancy super cars, fancier homes and fancy financiers — where the stench of excess is masked by the sweet scent of success. Except for one small difference — New York (aka Wall Street) and San Francisco do one thing better than London: branding money.

Actually, money — whether it is in Bogota or Bombay (Mumbai, if you insist) or Boston — is just money. Borrowing it, investing it or generally rolling around in a bed made of $100 bills is pretty much the same experience regardless of the source or geography of money. Except, somehow, some kinds of “money” are better than other kinds of “money.”

From bulge-bracket banks to white-shoe Sand Hill Road firms in Menlo Park, many of the hallowed names such as Kleiner Perkins Caufield & Byers have done a great job in creating a brand and mystique around money. During the Internet boom of the 1990s, Kleiner was the ultimate money brand, thanks to their backing of Netscape.

This ability to brand money has allowed big banks such as Goldman Sachs and JP Morgan Chase to thrive, even amidst a financial crisis. Massive amounts of capital and the eminence of their networks of contacts has allowed these two giants to brand money like none other.

Silicon Valley has been playing a variation of the same game: there are gobs of money, networks of famous people, and all are sitting on stacks of cash improved by the names of the successful startup founders that earned it. This often translates into a bigger brand, and thus giving more eminence to the money provided by the investors.

Up and down Sand Hill Road, everyone played from the same playbook. It was a perfectly lovely game plan, except the world changed with the arrival of first, the internet and then the social media. But before we get to that, let’s turn back the clock to the 1990s.

Internet kills

In my life, I have been very fortunate to chronicle the emergence of the commercial internet (as we know it) from its early days. Over next decade or so, I came to realize the amazing deflationary powers of the internet. It was — and still is — a great deflator, squeezing out middle men, friction and of course, profits.

There have been many such examples. In the late 1990s, fueled by the internet stock bubble/boom, a new class of traders came to exist: day traders. In a 1998 cover story, Forbes chronicled the escapades of this group of what it called “guerrilla market makers” who competed against major brand-name market makers such as Merrill Lynch, Goldman Sachs, Morgan Stanley, and Knight Securities. With little overhead, playing with their own money and risking it like those crazy poker players, the day traders reduced the spread in over-the-counter stocks and in the process squeezed what was a profitable (and inefficient) system. Before the day trading dudes showed up, the market as Forbes described so well was like a club.

For years, if you wanted to buy a company’s stock, your order went to a market maker who got you the stock at your offer price, even if they got it for less. They pocketed the difference and that was the spread. It cost millions of dollars to become market makers and thus be part of this special club. The Securities & Exchange Commission, having gotten wise to these dreaded and excessive spreads (thanks in part to some excellent reporting by Forbes magazine) changed the rules and let the barbarians into the game.

In 1998, about 2,000 of such day trading dudes (and they were mostly dudes) accounted for nearly 12 percent of Nasdaq’s trading volume. I learned about this specific day trading business when freelancing for Traders’ magazine and writing about electronic crossing networks.

This was all driven by financial innovation. The cost of trading collapsed for both regulatory and technology reasons, which allowed many, many more people to trade. More traders meant more wild behavior in the markets, and the phenomenon eventually collapsed in the dot-com bust — but the innovation (lower-cost trading) remains.

The history of financial markets is full of these kinds of stories. Some innovation makes some financial product or technique less costly, and it, in turn, becomes more widely available. People race to try it, hoping to earn higher returns, and that works; for a while, anyway. Inevitably, however, the innovation attracts too many newcomers that those returns collapse, leaving huge losses, but also leaving the innovation behind for the future to benefit from.

JOBS and Angels

Naval Ravikant, AngelList

Fast forward to 2013 and we are seeing history repeat itself with new financial innovation dropping regulatory barriers, lower costs, and driving much wider participation in a previously closed market. The club-like closed ecosystem of startup investing is about to be pried open, thanks to new rules from the Securities & Exchange Commission, which has approved many reforms as part of the Jump Start our Business Startups (JOBS) Act. On Monday an 80-year-old rule on general solicitation (by companies) was changed and it is a key part of the JOBS Act. Soon, another more sweeping change to the rules is going to be implemented and that will totally redefine the way startups are built and financed.

During the day-trading revolution, the biggest beneficiary was Island/Datek Online, a day trading platform started by Joshua Levine and Jeffrey Citron. The analogy in the startup world is AngelList, a startup funding platform co-founded by Naval Ravikant and Babak Nivi. Also on Monday, the company received a whopping $27 million in funding from a group of 116 investors including Google Ventures and Kleiner Perkins Caufield & Byers and Draper Fisher Jurvetson. In short, AngelList is a marketplace that allows the buyers (angels) and sellers (startups) to come together.

In reporting on the funding, Businessweek reporter Ari Levy wrote: “he’s focused on eliminating inefficiencies, like the amount of time and money early-stage companies have to spend on setting up meetings, traveling to pitch sessions and finding and paying lawyers.” AngelList expects to make money by helping with recruitment, Business Week added. But Levy’s article’s title says it all: Are VCs Investing in Their Own Disruption?

The answer to that question is Yes. The venture capital business, as Naval has pointed in many previous interviews (with me), is wrought with inefficiencies and inconsistencies. It has many sources of burdensome and irritating friction. (That friction is the equivalent of the “spread” in the old over-the-counter trading.) When I last wrote about AngelList (which was long before it became the media darling it is today) it was fairly obvious that it was a major disruption in the old way of doing things, i.e., investing in startups. And while it is difficult to predict its future, the change it has unleashed will continue to have longer term implications.

AngelList is not alone — others such as WeFunder, RockThePost, TechShop and Circleup have become part of the crowd-fund-the-startups movement. The ultimate democratization of investing in startups has already begun, and while some might call it the idiocy of the crowds (for many of the right reasons), the reality is that the (angel investor) mob is on Sand Hill Road.

Once again, financial innovation has cut costs and driven wider participation in a previously closed and clubby market. We have seen it over and over, from derivatives to mortgage-backed securities, and it is playing out again in angel investing.

And while the barriers to entry are coming down, the fact remains that startups remain an inexact science and are good ones are few and far-between. The trick is identifying the right one and then betting it would turn out to be a big-winner. As my former boss says, startups are like brilliant novels — there’s only so many out there among the crap.

The rise of the social VC

Dave McClure in Geeks on a Plane in May 2012.

In the very near term, I don’t think anything major happens to the venture capital industry. After all, the industry has been slowly contracting since its 1990s-bubble heydays. Eventually, however, the impact of the new investment approach that allows angels to band together and plow money into startups is going to have an impact on venture capital. In a sense, social media is already transforming the venture business. The emergence of blogs, Facebook and Twitter have reshaped the idea of a VC brand and how it is created in the 21st century.

For nearly four decades, the historical success of a partnership gave it its imprimatur and that in turn created a flywheel of success. The best investors had the best returns because they saw the best deals. It was their moat.

Lately, however, that competitive advantage has increasingly has been replaced by the “reach” provided by social media. Dave McClure was an obscure and quirky guy when I first met him in mid-2000s. A colorful blogging style, an orally eclectic twitter feed and tireless approach to investing in anyplace across the planet has made him (and his company 500Startups) a new VC brand — not a big one, but not ignorable either.

Is McClure the only one? No! Hunter Walk was a Google/YouTube executive who catapulted from anonymity, thanks to his understanding of social media and now co-runs Homebrew Capital, a seed fund with Satya Patel, formerly of Twitter.

I have often argued that one of the (good and bad) side effects of social media is that it amplifies both reality and fiction. And we are seeing emergence of newer investor brands, ones that are validated less by their decades of success, and more by followers and ability to attract attention. Attention, begets deals, and the circle turns.

AngelList fits neatly into this new investor model: it gives founders of startups, metrics about an angel — their track record, deals they are involved in and the size of their network. Yes, AngelList, like other tools of social validation, focus on the positive feedback loops, and thus one needs to be prudent by being skeptical.

The edge

Boom or bust, AngelList or CircleUp — the game has changed and it will continue to change, and that will keep sending the traditional venture community scrambling for ways to find an edge — one that allows them to keep branding their money and standout in this sea of noise.

Josh Kopelman’s First Round Capital is doing this through a founder platform and a publication, First Round Review. Even the tony Sequoia Capital is not immune to the changes and is launching Grove, a knowledge and information hub that is supposed to help its companies and founders. Andreessen Horowitz, a new firm than never misses a chance at publicity (and rightfully so) has hired my former colleague and partner in print, Michael Copeland, in order to create their own knowledge hub.

The reason? Perhaps it can be summed up by these words from Andreessen Horowitz PR chief Margit Wennmachers: the firm is “so connected, it’s the equivalent of the White House.” If there was a gold medal for PR, then Wennmachers should get one — she has ruthlessly helped turn A16z (as Andreessen Horowitz is known) into a PR force, from obscure conferences to Charlie Rose, founders Ben Horowitz and Marc Andreessen becoming first call for all comments on anything.

The success of A16z in the PR game has sent the entire Sand Hill Road community scrambling to hire communication partners (reminiscent of a similar scramble in the late 1990s). All of this hoopla is driven by one harsh reality: VC is now a game of attention. Less attention equals less attractive deals and these platforms/publications are a way to get that attention.

As great as these platforms might be for their firms, the approach I find most laudable is that of two of my favorite investors: Fred Wilson and Bill Gurley. Union Square Partners’ Wilson has been writing his AVC blog for almost a decade. It is less a marketing platform for his companies (he does some of that, but tastefully), but more a reflection of his life, his family, his thinking and the learnings he continues to share with his community. His blog only augments his track record as the winningest VC of the social generation.

If a founder wanted to understand Wilson, she would sit down and read everything Fred wrote in past year and get a fair sense of how and why he is thinking. You can see his flaws and also his strengths in those words. Others have tried to mimic his approach to blogging, but you can’t imitate and be authentic.

Benchmark Capital’s Bill Gurley

Same goes for Benchmark Capital general partner Bill Gurley, who probably makes the list of my top ten favorite human beings. Gurley and I met a long time ago when he was a financial analyst and I was a junior reporter back in New York. He used to write a column, Above the crowd, for CNET’s News.com. It was packed with detailed and interesting information and as a result I became more of a fan of his thinking.

He recently resumed writing the column, but as his own blog. His posts are deeply analytical and provide insights, which reflect his intellect. He is candid and you can see it on his Twitter feed. As a founder, Gurley’s blog and social feed are an authentic view into how he thinks about the technology landscape (and college baseball.) Again, the operative word is authentic.

Like I said on Twitter the other day, these days all content is marketing — but if I was making my choice, I would take Gurley and Wilson over portals and platforms. Call it authenticity over professionalism.

Exit orbit

And, by the way, as is almost always the case when it comes to Silicon Valley, it bears noting that none of this is new. The late 1990s saw talk of keiretsus and marketing partners and accelerators and incubators. Likewise, a desire to go international has come and gone a few times in the venture business. Even crowd funding had roots in Draper Fisher Jurvetson’s ill fated “meVC” fund. Sure a lot of these trends are being explored today in more sober and sustainable ways. But the ideas aren’t new, just as the idea of classic risk capital isn’t an anachronism.

Having spent over twenty years writing about Silicon Valley and its inner workings, one thing I have observed is that since 1999 is that the focus has become increasingly on winning “the deal.” That phenomenon was accelerated by the entry of newer funds into the business during the boom-boom years of the Internet. The upstarts competed with the traditionalists, offering outrageous valuations and using media as a way to stand out among the crowds.

Many of those hot funds are gone, forgotten or will soon be like the fading ink of a high-school notebook. Still, that relentless focus on “getting the deal” and using it as a success metric has stuck. In reality, it is an appropriate metric and reflection of our dopamine-addicted times: deals get attention… blah! blah!

I think the only metrics that should matter to a founder are the ability of an investor to empathize with them (especially when the going gets rough) and their ability to understand that startups are unpredictable. A really great investor knows that, and so should every founder. The bad investors are the polar opposite — just ask the folks behind the startups they backed in the past.

In a world where money is a commodity and startup funding is just a matter of being part of a platform, there is one thing that will always be unique: people and what they bring to the table. In London, the bankers to the billionaires are never seen — and are rarely talked about — they are busy making billionaires more money. You want that in your investor.

Hi Om, great post! Thereâ€™s one thing, though, that doesn’t change as the VC industry is disrupted and democratized. That is the critical role of the hands-on investor who works with founders. That hasnâ€™t changed for decades and it never will change. Itâ€™s hard to commoditize the things the best angel/VCs bring to the table: the empathy, business savvy, patience and the desire to work closely with founders. These are like the precious metals in a world of angel/VC paper-money inflation. Weâ€™ve got all these venture boot camps and online funding, but we should not forget the role of a really effective, involved board member who supports their companies through the often long and messy early years.

Disrupting Sand Hill Rd is fine, as long as we have more investor/mentors who understand that squiggly line to success and are able to work with founders.

Thanks Om for a great article. All of the changes happening in venture are incredibly positive for investors, entrepreneurs and I think ultimately returns. As others have commented – people and what they bring to the table captures it well. Authenticity, real value, empathy and partnership are a big part of what drives success.

Interesting piece. I was intimately involved in the trading world. Initially, it was democratized from the Club. But, the Club has used it’s money and influence to change the rules via regulation to re-create a different club that only a select few can be a member of.

In the commodity trading world, to compete with the big boys carries a price tag of $50M.

Venture will change, and I suspect if one can take Bayes Theorem and combine it with economic incentives, they will have a winner.

Beautiful ending: “In a world where money is a commodity and startup funding is just a matter of being part of a platform, there is one thing that will always be unique: people and what they bring to the table”

Great writeup giving traditionalist old guards a glimpse of their demise unless they adopt to technology. Indeed, the world will get flatter and more transparent as technology advances our intelligence. At the end of the day, it is how we leverage this intelligence (big data) that will differentiate us players in the money re-branding game. It will be a contest between the right brain innovators and the left brain (taken over by machines/ algorithms) analysts. We have barely scratched the surface. For now, Naval and his AngelList team are the heroes of the day. Watch what happens to their products. What a beautiful world we live in.

Vcs are managing to disrupt themselves with or without new funding platforms. Over a ten year period they’ve been unable to match the performance of an S&P 500 index fund. This “smart money” isn’t as smart as middle class librarian from the mid-west investing in a safe index fund.

The world is awash in money and there are few and fewer opportunities for it to act as investment capital especially since “too big too fail” means little capital is destroyed â€“ a primary requirement for healthy profit margins and new investment opportunities.

More funding platforms for rich investors might help speed up the destruction of capital but it requires the vehicle of startups, young teams told to dream big, yet most destined for failure, or sold into corporate cubicles for four years before they earn out while their investors cash out as early as possible. Terrible waste of youth, imho.

Great post Om. Just wanted to point out the importance of decimalization to the changes on Wall St. and demise of day traders. I was a NASDAQ market maker before I moved to SF. The analogy to VC is that micro-funds and angels are more capital efficient and can operate on “base-hits” of 2-3x returns, versus institutional VCs (paying marketing partner salaries) requirements to make 10x for their fees and LPs.

I guess having transitioned from covering public markets to private markets does give a slightly better understanding of the trading mentality. I hope SF has been good to you. I would love to hear what is your prediction for the future looks like.

Om, you are absolutely right that the only thing that matters is the ability of the investor to understand and empathize with the entrepreneur. Yet, if we measure the VC industry on that metric, we’re further from the ideal than ever before.

The Arthur Rocks that empathized with the likes of Apple and Intel are nowhere to be seen. Instead, we have an industry of wealthy plantation owners practicing Darwinian selection on sharecroppers. They’ll take increasingly extreme risks in hopes of finding the next Google rather than just building a solid growing company. At the seed end, there are endless investments in technologies that would once have been considered only features and not products.

Angels are not the answer. They simply fuel a bigger group of sharecroppers for the Series A Crunch investors to choose from. Who will live or die? Entrepreneurs are expected to take all the risk–build the product, get the customers, and show the momentum on their own nickel. No longer can a great team and an idea command much investment.

Entrepreneurs watch liquidity receed further and futher into the distance–now you’d better be able to tell a Billion dollar story and soon a 10 Billion story. Acquisitions are acqui-hires so we can double down on some other low likelihood bet.

As a consequence, we’re not building any more Oracles, Intels, or Apples. VC returns are lower than ever. They much prefer investing in kids who don’t know the game yet and haven’t been burned. I did 6 VC startups. 2 good acquisitions, 1 IPO, all many happy returns. Not a single one could be funded in today’s world.

As long as these excesses continue, the real future is bootstrapping. You have to do everything a bootstrapper does anyway to get real VC, so why give up shares of your company rather than just keep going?

Look to the 37Signals and the Smugmugs. They are the future until this industry really gets in line with entrepreneurs and adds value.

“People race to try it, hoping to earn higher returns, and that works; for a while, anyway.”

Most investors will invest in like 2-5 startups and will get burned as that is no way to invest in early stage companies. However, a few will get super lucky and hit it big which will get more people into the rush…. until the bust cycle hits.

However, this whole change WILL be good for startups. Having all the money/power in just a few VCs hands is bad for business. VCs can demand crappy terms and control over the entrepreneur which makes so many entrepreneurs decide not to take money. If this goes away there will be much more growth.

Yes OM, the playing field is leveling off as you point out. Those clueless VC’c who were shooting darts, getting lucky and looking like Genius may feel the competition. However, we won’t know (as Buffett says) who was swimming naked until the tide goes out. Thanks for a sensible and well researched article.

Bill is the best in the business. i only wish he would write more. so much to learn from him.

your ending is the best part of this Om. the only thing that matters in the end is the ability of an investor to empathize and understand a founding team and the company they are building. everything else is bullshit, as commodity as the money itself.

Nice post Om. But I would suggest that for Dave & 500S this is much less about “the changing of the guard in our corner of the world” and much more about creating new guards in every corner of the world.

When I was a young entrepreneur growing up in London a few years ago, the most glamorous investment vehicle I’d look to was 500 Startups; I hadn’t heard of DFJ and co – despite the former being about 1 year old at the time and DFJ close to 30. McClure’s branding genius is to appeal to foreign start-ups and make himself accessible to them. So when a breakout success does come up, it’s Dave and 500S that they’re aspiring to pitch and respect (e.g. 9Gag from Hong Kong etc).

Through creating micro-funds in neglected economies such as Latin America, India etc. I think that 500 Startups biggest impact is much to be felt much more in these developing regions than it is back home. It’s like a popstar who only performs in one city, vs one that’s doing world tours every day of the year.

As to AngelList, I don’t think that we’ve even scratched the surface of the potential that’s going on there. I think that Naval is building a beast that’s going to blow stuff up. VC firms like to talk about how they can help you with recruiting and marketing etc. and hire armies of people who can often have just marginal impact (you can’t throw people at a lot of these problems), Naval by contrast is instead building a platform that automates all of these functions. And to say that it’s automating the functions perhaps isn’t doing it justice – they’re blowing up the ideas of how they should take place. Recruiting is in the top 3 challenges that a startup will face and the AngelList recruiting platform is perhaps the most effective that I’ve ever used.

AngelList is building a hub where all your startup activity takes place, the dashboard you check first thing every morning. Oh and this is without even getting started on the potential that it has as a fundraising platform (now and in the future).

That is an epic comment. I couldn’t add more, except that I totally agree with you on your assessment of Dave – going to places where no one was willing to go has been a great edge for him and that ultimately is going to be his brand.

rather long piece, Om… guess you didn’t have time to write a short letter? ;)

thanks for the [literal] hat tip.

agreed Wilson & Gurley are class acts, and have admittedly vast reach via their blog & community. however, i don’t think you have to choose between great VCs and “platform” benefits. hopefully the good ones come with both.

Gurley is a class act? Really? Are we forgetting about the Epinions lawsuit where Gurley (along with his sidekick Nirav Tolia) and August Capital allegedly tried to screw the rest of the Epinions founders and employees out of their fair share during a liquidity event? The rest of the Epinions employees included none other than Naval Ravikant, who was so disgusted by the VC experience that he went on to start Venture Hacks and AngelList. Such a short memory in the Valley these days! In a way, you could argue that Gurley and Tolia were the inspiration for AngelList.